Treasuries Predicting A Crash? Rare U-Shaped Yield Curve Warning?

Bad financial times have historically coincided with/been preceded by U-shaped yield curves - what we have right now. Is the current U-shaped yield curve an omen for what's to come and should you stop buying 2, 5 and 7-Year Treasury Notes? Plus, what's the difference between a normal, U-shaped and inverted yield curve, and what do they mean?

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U shaped yield curves are rare and have historically foreshadowed or coincided with bad financial times. Is this where things are headed and should you stop buying two, five, and seven year treasuries? Hello Diamond Nestec members, Super Savers and Course fans, I hope you're healthy and well. At the time of this taping, the yield curve in the US has been gradually moving back into its normal positive shape after a long time when it was inverted after COVID. But it's still not quite there yet. In fact, while yields on the long end are now higher again than on the short end, as they normally are, it's not a straight line because there remains a dip in the middle, meaning that middle maturities show lower yields than either the very short or the very long maturities. Such U-shaped yield curves are rare. They've only happened a few times in recent US history, and all of those times have foreshadowed or coincided with major financial crises. So, with that in mind, here are the three topics I'll be covering today. 1. What is the importance of normal versus inverted yield curves for bond investors? 2. Why would a normal yield curve invert and what challenges does it impose for bond investors? And three, what should bond investors consider during the rare occurrence of a U-shaped yield curve like the one that we're seeing right now at the time of this taping? And in this section, we will focus specifically on those of you in our community interested in the popular two, five, and seven year maturities. Let's dive in now, folks. What is the importance of normal versus inverted yield curves for bond investors? So, one of the fundamental principles of bond investing is that the longer the time to maturity, the higher the return a bond investor should demand. Because the longer the time to maturity, the longer the bond investor is exposed to these bond risks, either some or all of them, depending on the type of bond. What this means is that under normal circumstances, all else being equal, if you were to buy a 10-year bond, it should pay more than a one or two-year bond. Because the 10-year bond will expose you to some or all of these risks for a longer period of time than a one or two-year bond. Plus, you're also tying up your money for longer and may want a bit of a premium for that. And this is what a normal yield curve looks like. Because in a normal yield curve environment, the longer the time to maturity on a bond, the higher the yield. The graph is different in an inverted yield curve environment. It's essentially the other way around. And this is what an inverted yield curve looks like. The shorter the time to maturity on a bond, the higher the yield. Meaning that somewhat counterintuitively, you get a higher interest rate if you lock in your money for shorter. The market most often defines whether the yield curve is normal or inverted by comparing the yields on the 10-year treasury to the two-year treasury. In normal times, with a positive yield curve, a 10-year treasury that ties up your money for longer should have a higher yield than a two-year treasury that matures much earlier. So let's take a look at this chart from Fred, the regional St. Louis Federal Reserve Bank in the overall Federal Reserve System, which has lots of useful macroeconomic and bond data on its public website, by the way. So this chart from Fred shows you the difference between the yields on the 10-year and the two-year Treasury. Where the blue line is above the black zero line, this difference was positive, meaning the 10-year paid a higher yield than the two-year. You can see that this was the case in the early 2000s, as well as at the time of this taping here, indicating a positive yield curve or normal yield curve. As I mentioned before, however, starting after COVID in 2022 and well into 2024, we were in an inverted yield curve environment where this blue line was below the zero line and in negative territory, meaning that longer dated 10-year treasuries were yielding less than shorter dated two-year treasuries, which is a nice segue into the next part of today's discussion. Why would a normal yield curve invert and what challenges does it impose for bond investors? So why would the yield curve ever invert? Or in other words, why would investors ever accept that they get less interest if they tie up their money for longer? Well, on a high level, this is how it happens. In the beginning, the Fed raises short-term interest rates, usually to bring down inflation. Remember, the Fed can only directly influence short-term interest rates. They cannot directly influence long-term interest rates. And under normal circumstances, the market assumes that if short-term interest rates go up, long-term interest rates should also rise, even if this may not always be a one-to-one relationship. Problems arise when the Fed raises short-term interest rates so high and or so fast that investors think this will slow down the economy because the more expensive it is to borrow, the fewer loans businesses and consumers will take out for immediate use andor future investment. The yield curve inverts when investors fear that the Fed is overdoing it, so to speak, and that the economic slowdown from higher short-term rates will be so strong that it will lead to a recession. And when a recession happens, the thinking is that the Fed will have to cut rates again and cut them fast to re-stimulate economic growth. And if that's what investors expect, a coming recession and sharply lower short-term rates in the not too distant future, they may just buy longer-term bonds to lock in current rates for longer, even though these rates are lower than what they could get for shorter dated investments. It's essentially a trade-off between higher for shorter versus lower for longer. That's the reason why an inverted yield curve is often seen as a predictor, a sign of a coming recession. But it's important to remember that is all it is, a sign of what the market expects may happen. It doesn't mean that every inverted yield curve is followed by a recession, as we saw from the latest inversion episode between 2022 and 2025. Now, outside of a possible recession, there are other explanations out there for why the yield curve would invert. But let's table those topics for another day. Otherwise, we'll never get to our current U-shaped yield curve. An inverted yield curve poses a challenge for bond investors because everyone needs to decide for themselves whether they should tie up their money in the longer-term bonds with a lower yield, but at least have the certainty that they'll keep those rates until they mature. For example, for their long-term retirement planning. Or should they be tempted by the higher rates that short-term bonds offer, maybe because they think that the predicted recession may not really be around the corner after all, and that the Fed may keep short-term rates higher for longer. And one more point to note here the standard bond strategies out there generally assume a normal yield curve. And in most cases, these standard bond strategies will need to be tweaked a bit for lack of a better term, when there is an inverted yield curve. Bondmasters course, folks, please refer back to Module 3 for more details on these bond ladders and other bond strategies. And similarly, in a U-shaped yield curve environment like we have at the time of this taping, modifications to your intended bond strategy may need to be made, bringing us nicely to the next part of today's discussion. What should bond investors consider during the rare occurrence of a U-shaped yield curve, like the one that we're seeing right now at the time of this taping? So this chart shows all treasury maturities from one month to 30 years. And you can see the U-shaped yield curve that we have at the time of this taping. Well, it's not really a clear U as printed, but you get the picture. Yields for short-term treasuries are lower than for long-term treasuries, but the lowest rates are found in the middle dip, especially for the one, two, and three year treasuries. And the number on the very left, that's not a treasury yield, but the rate for reverse repo operations, or RRP. So essentially an indicator of very short-term secured overnight rates for comparison. You can ignore it for the purposes of this discussion. U-shaped yield curves have only appeared in six episodes in the past 50 or so years, according to this study from Chatham Financial, a global financial risk management firm. In 1989, before the recession of 1990-1991, in 1998 during the Asian and Russian financial crisis, in 2000 when the internet bubble burst. In 2007, before the Great Financial Crisis, these three lines here. In 2019, preceding the COVID-19 pandemic-driven recession. And in 2024-2025, the episode that we're still currently in. As you can see from this table, the first five U-shaped yield curve episodes did not coincide with good financial times. That said, just as an inverted yield curve does not predict a recession every time, a U-shaped yield curve does not have to automatically predict a financial crisis every time either. No one can predict the future. In our mind, and as we've discussed regularly on this channel, the current U-shaped yield curve may reflect three things. First, on the short end, there's really no clear direction where rates may go at the moment. The Fed is in an uncomfortable position as it has to balance competing demands from inflation versus unemployment. Lower rates too quickly and inflation may spike again. Raise rates too quickly and the economy may go into recession and unemployment may spike. So it does seem to be a bit of a waiting game with the Fed's finger on the pause button for the time being, which has kept rates stable since the end of 2025. Second, on the longer end, higher yields may reflect uncertainty around continuing economic growth, our growing debt pile, and maybe higher inflation, not to mention the currently ongoing war in Iran and subsequent rise in oil prices. Third, and again on the longer end, investors may simply not want to tie up their money in 10, 20, or even 30-year maturities as a result of this rising uncertainty around the economy, debt growth, inflation, and other matters, and as a result are piling into the middle maturities in a sort of holding pattern. So, where does this leave bond investors in our community who have a two-year, five-year, or seven-year timeline for their fixed income investments? And I know these are popular maturities here because we take a poll every month in our VIP investment club where our VIP members choose their preferred date for a monthly member live. And the weekend before the two-year, five-year, and seven-year treasury auctions is usually the winning date. And if you're interested in joining this month's VIP member live on March 22nd, the weekend before the two-year, five-year, and seven-year treasury auctions. Or if you have a specific investment idea that you're already considering and you want a second, third, or even fourth pair of eyes to have a look as well, then come on over and join our private VIP investment community. Because that's what Marcus, our VIP members, and I talk about on a daily basis. Visit our website at www.diamonestic.com and click on this yellow private VIP investment club button to learn more and join our member conversations. I've also linked everything below this video for your convenience. Going back to the question of where the U-shaped yield curve leaves bond investors in our community with a two-year, five-year, or seven-year timeline for their fixed income investments, there are a few factors to consider in this current U-shaped yield curve environment if your target is medium-term maturities. First, if you do not need the regular income from coupon payments, consider a MIGA, a multi-year guaranteed annuity. So if we look at this MIGA versus Treasury rates table, at the time of this taping, the MIGA rates beat the Treasury rates for all maturities three years and higher. As a reminder, these MIGA rates are from an A rated insurance company that we work with. A double plus is the best credit rating that an insurance company can get from AM Best, which is a ratings agency that specializes in the insurance industry, meaning the lowest risk, making the MIGA rates here the most comparable to Treasuries in terms of risk return profile. And remember that mygas work essentially like a CD, similar to a bond, except that mygas do not pay interest regularly but accumulate it in the myga account and pay out everything together at maturity. So if you purchased a$100,000 seven-year MIGA, your rate would be 4.5% at the moment versus about 3.98% for a treasury, so more than 50 basis points higher with the myga versus the treasury. Do keep in mind that treasuries are more liquid than mygas because you can sell them before maturity on the secondary market at whatever the then prevailing market price may be. Mygas usually only allow you to withdraw some part of your capital per year without penalty, for example, 10%. This liquidity advantage of treasuries over mygas is also one of the main reasons why treasury rates are normally lower than myga rates. Also remember that the myga rates in this table are at the time of this taping and subject to change at any time without prior notice, and that your personal rate may be higher or lower depending on a number of factors, including how strongly or not so strongly the insurance company you're buying your annuity from is rated. Meaning how risky or not risky your insurance company is. As a general rule of thumb though, and all else being equal, the higher the rate, the lower the credit rating of the insurance company, similar to bonds. That said, your personal rate will also depend on your investment amount, annuity type and term, state of residence, and other circumstances. Your personal rate is not fixed before you sign your annuity contract. Annuities come in many different flavors and should be customized to your personal situation. So drop us a note at jennifer at diamondestic.com if you're interested in getting connected with our trusted annuity specialist and finding the one that best suits you. Moving on now to the second option to consider in this current U-shaped yield curve environment if you're a bond investor with a two-year, five-year, or seven-year timeline. If you do need the regular income, shop around for higher yielding agency bonds and or CDs that allow you to withdraw the interest payments. Pons Direct Bank, for example, is offering 4% APY on a 24-month CD. Just keep in mind that interest earned on CDs and some agency bonds is taxable at all levels, whereas interest earned on treasuries is only taxed at a federal level when held in a normal taxable brokerage account. Plus, and this is a point for all CDs and other bank products, always make sure you stay within FDIC limits. Moving on to the third possibility, which is simply to stick with treasuries. For example, because you want liquidity and the guarantee by the full faith and credit of our country. Remember that despite the dip in the middle maturities, yields are still higher now than where they were on average over the past two decades. This is where the two, five, and seven year maturities stand at the time of the taping. And this is where they averaged over the past five years, the past 10 years, the past 15 years, and the past 20 years. So if we look at the seven year again, it's more than 50 basis points higher than the five-year average, and more than 130 basis points higher than the 10-year average. In other words, even in the current U-shaped yield curve environment, the middle maturities are still in a good place relative to where they've been since 2006. So if you don't want to look for higher yielding MIGAs, CDs, or agencies and want to stick to treasuries for their liquidity or any other reason, there's really nothing wrong with that either. As we always say, your investments should not keep you up at night. And sometimes the few extra basis points in yield may simply not be worth it if they do. But that's me, and everyone's financial journey is different. And of course, we'll keep watching what's happening in the markets here at Diamond Nestec and share our perspective. Again, drop us a note at jenniferdymonestic.com if you're interested in getting connected with our trusted annuity specialist and finding a higher yielding annuity that best suits you. Or come check out our private VIP investment club, where we continue to explore other higher yielding income opportunities that can supplement your overall portfolio. I've included all the links below this video for your convenience. Alright, members Super Savers and Course fans, I hope you enjoyed this video and learned something new. And see you very soon with more brand new wealth building content for your financial journey.